Mixed signals on house finance

National Australia Bank
chief executive
Cameron Clyne
says we live in a 10- speed economy that is full of confusing signals, in­cluding a drop in home lending at NAB this year from $10 billion a month to $6 billion a month.

Clyne says this 40 per cent drop in NAB’s home lending because of lack of demand came at the same time as unnamed competitors were offering discounts of 1.15 percentage points on their standard variable rate loans.

He says there are other danger signs in the home market, with some competitors offering loan to valuation ratios of 90 per cent. These comments suggest some banks in ­Australia will be headed for trouble in a couple of years, with a possible surge in bad debts because of imprudent lending.

Clyne’s anecdotal evidence of consumer uncertainty about housing investment, and warnings of aggressive lending practices by rivals, sit oddly with the stories about loan refusals coming out of the residential property industry.

First-home buyers who have had their credit worthiness screened by residential developers have been refused home loans by the big four banks, according to industry sources. This has resulted in complaints to the Australian ­Valuers Institute, which represents property valuers.

Clyne says the difficulty in reading the economy is compounded by the contrasts between the strong fundamentals reported by NAB’s business customers and the low levels of confidence among households.

NAB’s head of business banking, Joseph Healy, says NAB is now dealing with three years of below system credit growth by businesses operating outside the resources sector. He says small to medium sized business are struggling and that is reflected in higher bad debt charges.

The 7 per cent increase in NAB’s cash earnings, excluding provisions from the United Kingdom, shows that Clyne’s strategy of offering the most competitive home loans and cutting bank fees is working. But the strategy comes at a cost to the bank’s net interest margin, which fell 15 basis points in the personal bank.

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However, a strong focus on costs and an increase in margins in New Zealand helped NAB come through with a decline in net interest margin of 11 basis points. Analysis by KPMG shows that NAB is the most efficient bank among the big four, with the lowest cost to income ratio.

The $2.3 billion refinancing, sale and lease of the Sydney desalination plant for $2.3 billion is a good result for NSW Treasurer
Mike Baird
who needs to fill a $5.8 billion hole in his June budget from lower goods and services tax receipts.

The plant is being refinanced and leased by a consortium including the Ontario Teachers Pension Plan Board and two Hastings-managed infrastructure funds, Utilities Trust of Australia and the Infrastructure Fund. The government was advised by Goldman Sachs. The financial adviser to the consortium was ­Morgan Stanley and its debt adviser was RBC Capital Markets.

It is clear from the deal that regulated infrastructure assets with government guaranteed revenue remain very attractive to pension and ­specialist funds. The consortium has a 50-year lease over the plant and is entering an agreement to supply water for 40 years, with an option for another 10 years. The deal includes a government-guaranteed availability charge for when the plant is not in use.

The sale price, which is equivalent to 1.15 times the regulated asset value (RAV) of $2 billion, is almost smack in the middle of the range for similar recent transactions overseas of 1 to 1.25 times RAV.

About a dozen banks have been happy to refinance the project, which in some respects could be likened to a souped-up semi-government bond.

Assuming a 2.5 per cent margin over the bank bill swap rate of 3.7 per cent you get a lending rate of about 6.3 per cent plus fees. That looks attractive compared with a three-year semi-government bond paying 3.5 per cent.

The third point is that in order to get to a RAV of 1.15 times you have to have very high gearing. The government tender assumed a debt of 60 per cent and equity of 40 per cent whereas the sale price looks like involving a debt of 75 to 80 per cent.

That sort of gearing has been seen before in Australia on regulated assets but only when the transaction included a portion of unregulated revenue that could be cranked up by the new owners.

The desalination plant deal does carry risks. The weighted average cost of capital could change if the Independent Pricing and Regulatory Tribunal changes the price paid for water.

Water is priced at $2.20 a kilolitre in Sydney.

The desalination plant transaction includes an availability charge of $1.70 a kilolitre.

The sale was completed rapidly thanks to the fact that the plant has been running for about two years and therefore does not carry ­construction risk. The transaction will cover the $1.994 billion value of the plant in the balance sheet of Sydney Water, which will therefore not have to make an impairment charge.

Baird will be able to repay the $1.7 billion in debt attached to the plant.

He plans to put $300 million in the NSW government’s infrastructure fund, Restart NSW.

About $20 million in fees and charges was eaten up by the lease on premises in Sydney while the transaction was in progress and fees paid to bankers, KPMG and King & Wood Mallesons.

The kicker in the deal that should work to the advantage of consumers is that the remaining 10 years of the water supply agreement will only be available if the consortium is supplying 20 per cent of its output to third parties.

This is an incentive to encourage competition. For example, the consortium could do a deal with AGL to supply water to its customers. AGL already supplies electricity and water to its customers in Canberra.

Alternatively it could supply water to industrial users.

It will have an incentive to buy water from Sydney Water because it is cheaper than water produced by the desalination plant.

The strange thing about this entire transaction is that the plant will be shut down on June 20 and probably remain out of use for about three or four years while dam levels fall below 80 per cent. Its membranes will be stored in special containers while the plant is mothballed.

As predicted in this column several weeks ago, Optus will appeal against the TV Now decision in the High Court. It wants a ruling on whether or not Australians can use cloud computing to copy material broadcast on free-to-air TV and watch it at their own convenience.